Oilpatch Casualties : Price War Enters The ‘Market Death’ Phase

The “market death” phase of the oil downcycle is about to commence as margins of many producers are starting to dry up, according to an energy analyst.

Claudia Cattaneo: With the Canadian dollar depressed and share prices of some companies at bargain levels, the odds are high that well-known Canadian names will disappear.

“We are in the midst of a price war and one of the key elements of a price war is that producers start to raise production to elbow out the competition,” Peter Tertzakian, chief energy economist and managing director of ARC Financial Resources told a business audience at a conference in Toronto Thursday.

Last November, Saudi Arabia and OPEC allies decided to maintain output despite falling oil prices, triggering a global oil war that has seen prices cut in half.

“First thing you do [in a price war], is you crank up capacity. You have to pay the bills, employees and banks. You crank it up, till you can’t crank it up anymore.
Until you hit Phase 2, ‘Market Death’, which sounds very ominous. Market death is when some of the participants can no longer produce and start dropping out. It’s starting to happen, not enough yet.”

We are still in the first phase, with market death about to occur.

“And at some point there is capitulation. I would argue that it is coming in the third and fourth quarter, but it could drag on for a year,” Tertzakian said.

The OPEC meeting in June is unlikely to see the Saudis retreat from their determined position of raising production and gaining greater market share at the expense of their competitors.

“I don’t think they [the Saudis] would have felt that enough market death has happened yet. The objective in price wars is to put the weak out of business.”

The silver lining for Canadian and U.S. producers is that tight oil is more responsive and nimble compared to the inelastic conventional global supplies. This is evident from the financings of Canadian oil producers, which have been almost at the same pace as the first quarter of 2014.

“Light oil is going to be winner in the global price wars and the investor sentiment shows that. But the money is going to be very selective and backing winners – perceived winners.”

“The longer [low oil prices] persist, the more you will see companies’ financial situation become more precarious, and potentially looking at being acquired as the best outcome,” said Scott Sharabura, associate principal at McKinsey & Co.’s Calgary office.

At the same time, their businesses remain attractive, he said. “Everything about the logic of investing in Canada — lots of reserves, a safe environment from a geopolitical perspective, low risk, lots of long-term investment potential — still holds.”

Among the larger companies, oil sands producer Cenovus Energy Inc. and oil and gas producer Encana Corp. saw the steepest stock price declines since the beginning of the year. Cenovus issued $1.5 billion and Encana $1.4 billion in equity to soothe the bite of low oil prices. But Cenovus still has a $1.3 billion “funding gap” and Encana is digesting acquisitions it made at high prices as part of its transformation to become a balanced oil and gas producer before oil collapsed.

Penn West Exploration Ltd. is among those struggling with high debt and has been in discussions to ease terms.

“Companies will doubtless feel the squeeze as time goes by and Q2 2015 will inevitably be a time when we see an increase in distressed sales as debt-laden companies have their hands forced by the need to furnish debt,” Eoin Coyne, of research firm Evaluate Energy, said in a report Wednesday.

The most talked about potential acquirers are Canadian Natural Resources Ltd. and Suncor Energy Inc., which saw the largest stock price increases over the same period.

Canadian Natural has been acquisitive throughout its history, particularly when industry conditions are weak. Suncor became acquisitive in the last oil price crash, when it purchased PetroCanada.

Husky Energy Inc., whose stock has been relatively stable, has signalled it has appetite for a “transformational” deal.

But global companies are also likely on the hunt, and in some cases have the benefit of stronger currencies and deeper pockets. In addition to Shell, Petronas, ExxonMobil Corp., Chevron Corp., BP PLC, PetroChina, ENI, Total S.A, Lukoil and Statoil ASA have the financial capacity to make acquisitions, according to Evaluate Energy. With the exception of Lukoil, all have operations in Canada. The Shell-BG merger could push others to do their own deal to keep up, or because by eliminating competition they can reduce costs.

The 1998 oil crash pushed Exxon to purchase Mobil, and BP to acquire Amoco. Chevron later scooped up Texaco Inc. and Conoco took out Phillips.